When we think of a stress test, most of us visualize ourselves running on a treadmill in a hospital setting. Doctors perform this test in order to determine the amount of stress that your heart can tolerate before developing abnormal rhythm or to see if there's a shortage of blood to the heart muscle. Information produced from this stress test allows doctors to diagnose potential problems within a person's cardiovascular system. The value delivered from this test can be a lifesaver.

Incredible value can also be achieved through stress testing your business margins in much the same way. Analyzing different stress conditions such as an increase cost of production, limited marketing price opportunities, or decreased yield levels will allow you to determine the amount of stress your profit margin will be able to tolerate. Your business ultimately relies on cash in much the same way your body relies on blood. Determining what it will take in order to keep the cash flow moving is imperative when making production, marketing and risk management decisions.

Stress testing your margin is not a difficult process. As I've discussed before in previous blogs, the three variables that need to be stress tested include yield, cost of production, and market price. Here is a tool for analyzing various scenarios. Simply manipulate the variables "one at a time" into levels that would be stressful for your operation. This will give you immediate insight to the impact on your margin.

Stress Test Tool

Margin Analysis

Acres

1000

Total Production

175,000

Yield

175

Total Expenses

$845,000.00

Price

$5.75

Total Income

$1,006,250.00

Cost of Prod. Per/ac.

$845.00

Expense Per / ac.

$845.00

Income Per / ac.

$1,006.25

Total Net Income

$161,250.00

Net Income / ac.

$161.25

ROI / Margin

19.1%

There is significant value in understanding how margins are influenced by the changes in grain prices, rather than worrying about price alone. The same thing holds true for inputs and yields. You can’t just worry about one of these three variables independently without taking into account the condition of the others.

Your heart needs a normal rhythm and adequate blood flow. Likewise, your business needs a normal rhythm of cash flow, adequate working capital, and a risk management plan in place to help absorb any shortage in price or production.

Proper diagnostic equipment for analyzing your situation is essential to come up with the proper diagnosis and eventually the best remedies for successful decisions. The value delivered from this test could be a lifesaver to your bottom line.

As a farmer, I'm always amused by the questions from people living in urban areas that really know little about agriculture. One of my favorite questions usually comes after planting or harvest season, "so what are you doing now that the crops are in?" They see the physical part of farming but have no clue of the details which go into operating a successful farming business. The best response I've found for this question is that we really have 3 seasons in production agriculture; Planning Season, Planting Season, and Harvest Season.

We all put forth a tremendous amount of time and dedication during planting and harvest season. Only you know how much time and dedication is implemented into the planning efforts for your business. I would suggest that the planning season has as much potential to generate profits as the planting or harvest season.

If you could improve on these areas and lower the cost of production by as little as 2%, the payback is significant. For example, assume your cost of production is $800 per acre for corn. If you have 1,000 acres, 2% equals an additional $16,000 to the bottom line! Likewise, assuming a 2% improvement in your marketing and yield on the same 1,000 acres (180 bu. corn *$ 5.55 =$999 /ac. income) you would generate an additional $19,000! In other words, just a 2% improvement in your business could have the potential of generating $35 per acre or a $35,000 boost in your profitability!

A little planning can go a long way toward improving your margins! The next time someone asks you what you are doing in the off-season, what will your answer be?

Please send your questions regarding any of the above planning and management topics.

It's human nature to spend most of our time doing what we enjoy. As farmers, most of us prefer the "outdoors production" part of agriculture best; therefore, this is where we spend the bulk of our time. The results are evident based on the amazing yields we are able to achieve despite numerous challenges from weather, diseases, and insects. The extra effort we put into production pays big dividends.

Imagine the benefits, if the same attention was given toward all areas of your business. Challenge yourself to develop a list of needed improvements for your operation. Ask yourself; what resources do I need to improve the bottom line? In some cases, decision tools such as spreadsheets may produce better decisions. In other cases it may be worth hiring a third party to get you headed in the right direction. It's difficult to be good at everything. Applying your focus on what you're good at and allowing someone else to do the other stuff will not only make you more money, but it will also improve your quality of life.

One example I’ve observed many farmers benefit from is using a simple cost of production spreadsheet in order to track expenses and income throughout the year. Timeliness and flexibility are the two primary benefits from this tool. Profit decisions are usually moving targets. If you're using a pencil and paper to analyze this information, it becomes impossible to analyze various scenarios in a timely manner.

Here is an example of a basic cost of production spreadsheet.

Farm Name

Joe Farmer

Total Prod. $

$1,644,075.00

Total Acres

1,500

Expense/Ac.

$1,096.05

Crop

CORN

Gross $ /Ac.

$1,202.50

Market Price Goal

$6.50

Cost/Bu. Prod.

$5.92

Yield Est. / Goal

185

$ Margin Ac.

$106.45

Total Grain Production

277,500

ROI

9.7%

Total Expense

Bu. Needed

CROP EXPENSE LIST

Expense PER/AC.

OVERALL

PER/ AC.

Return to Management

$150.00

$225,000.00

23.08

Land Payment/Rent

$245.00

$367,500.00

37.69

Taxes

$25.00

$37,500.00

3.85

Interest

$15.00

$22,500.00

2.31

Insurance

$25.00

$37,500.00

3.85

Seed

$102.00

$153,000.00

15.69

Fertilizer

$86.22

$129,330.00

13.26

Nitrogen

$117.62

$176,430.00

18.10

Herbicide

$28.71

$43,065.00

4.42

Fungicide/Insecticide

$37.50

$56,250.00

5.77

Custom Spray 2 pass

$15.00

$22,500.00

2.31

Equipment/Fuel/ Labor

$173.00

$259,500.00

26.62

Grain Hauling

$37.50

$56,250.00

5.77

Drying Expense

$27.50

$41,250.00

4.23

Storage

$11.00

$16,500.00

1.69

Tile / Irrigation

$0.00

$0.00

0.00

Total Expenses / Ac.

$1,096.05

$1,644,075.00

168.62

Only you know what's best for your operation. The key is not how big your toolbox is, but rather, the quality of the tools inside.

I'll continue to build decision tools around cost of production, equipment replacements, line item expense management, market tracking, charting breakeven at every yield level, margin management, and other areas where I receive questions.

Feel free to send me your specific margin management questions. Let me know what tools I could provide to best help your decisions for 2012.